Great blog posts about macroeconomics

The Economic Health Insurance Market and the ACA

Few issues are as divisive as health insurance, especially in the United States. In order to understand the argument for the government intervening in the health insurance market, one must first examine the incentives firms and individuals face within the market.

Insurance is, by definition, a bad deal for the buyer and a good deal for the insurance company, assuming individuals are risk independent. As long as insurance companies have a good idea of the probabilities of the risks they are insuring, they are statistically guaranteed to make money run on average, in the long run, and, conversely, insurance buyers are statistically guaranteed to lose money on average, in the long run. The reason most people buy health insurance is that most are risk averse, and would gladly pay a premium in order to insure (no pun intended) that they never suffer one massive, devastating medical catastrophe that would financially ruin them.

This idea sounds good in theory, but upon further examination of the incentives of the individual and the companies, we can see why it market failure occurs, leaving many uninsured and those with insurance paying increasingly high amounts to stay insured. Because each person is losing money on insurance in the long run, a young, healthy individual may view the premium insurance companies have decided on as a bad deal, and decide not to purchase it. When many healthy, young individuals all decide against insurance at once, the overall pool of people insurance companies are covering becomes sicker and sicker, incentivizing them to raise premiums. This leads to even more healthy people dropping out, and insurance companies raising premiums even higher. Anecdotal horror stories aside, insurance companies are not evil corporations trying to squeeze every last penny out of sick and dying people; they are businesses responding to incentives while experiencing a situation of market failure.

The original idea behind the (insanely complex) 1000 page bill is indeed noble. Among other things, it attempts to alleviate upward pressure on insurance premium prices and insure the millions of uninsured Americans by forcing the private insurance companies not to raise prices to unreasonable levels for those seeking insurance who are known to have pre-existing conditions. Of course, this would eventually bankrupt the insurance companies as they will almost certainly lose a ton of money on these select individuals. Therefore, the corollary to this part of the law is to force almost everybody (including the young, healthy Americans who would rather not) to buy insurance, so that the insurance companies make enough money off of healthy Americans to cover their losses from the very sick people they are now forced to insure. Oversimplifying, this law results in a transfer of wealth from the healthy (typically younger, in-shape, and/or lucky individuals) to the unhealthy (typically older, out-of-shape, and/or unlucky individuals).

This transfer offends conservatives, especially those who champion an individual’s right to choose whether or not he wishes to buy a certain good. Libertarian Supreme Court Judge Antonin Scalia argued against the bill, claiming that following the logic behind Obamacare, the Federal Government could pass a law forcing people to eat broccoli, because broccoli is healthy for you and this law would have positive externalities on society as a whole, as society would not need to pay for as many heart transplants and other medical complications later in life. Defendants of Obamacare dismiss Scalia’s famous broccoli comment as a clever argument, but not necessarily a good one; the critical difference between the markets for broccoli and health insurance that demands the government’s intervention is the market failure discussed in paragraph two. Conservatives also argue that diminishing consequences will change people’s incentives and cause them to live more reckless lives; without having to bear the cost of their 5th heart transplant, people may choose to chow down on one more tasty Big Mac. Defendants argue that this is another clever theoretical argument, but not necessarily one that will play out in practice, as people do not tend to enjoy heart transplants. The word is still out on which side is right.

The health insurance market has historically proven a thorn in the side of America, leaving huge numbers of Americans uninsured, especially when compared with our European neighbors. The success of the ACA as a corrective measure to the market failure brought about by this particular insurance market will be determined by history, and measured, at least to some degree, by each individual’s personal political philosophy.

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3 thoughts on “The Economic Health Insurance Market and the ACA”

Health insurance is undoubtedly a fascinating and complex issue, with the Affordable Care Act adding more fuel to the fire. It is true that in order for the legislation to be successful, young, healthy individuals must enroll in order to offset the enrollment of older, unhealthier people. However, this goal is undermined by another part of the legislation, which allows young adults to stay on their parents insurance until they are 26. Another point of contention is the fact that insurance is a long term loss for young and healthy people, cheaper prices for plans would be needed to woo this demographic. However, this has resulted in insurers only signing up doctors and hospitals willing to agree to low-reimbursement rates, narrowing the amount of networks Americans are used to. Moreover, it has led to incredibly high deductibles and co-pays, far greater than the ones offered before Obamacare.

“Insurance companies are not evil corporations trying to squeeze every last penny out of sick and dying people; they are businesses responding to incentives while experiencing a situation of market failure.”

Well, they are trying to maximize profit, and one way they do that is to try to sell lots of insurance but provide as little health care as possible. Do you think health care is an area where you want the industry dominated by players trying to maximize profits?

I enjoyed your discussion of the current health insurance landscape in the US. Perhaps it is because I have worked in the investor relations side of healthcare and biotech companies in my internships, but I think an important part of the discussion that most people forget is the massive costs of actually making these drugs that are paid for by the insurance companies and used by the payers. It is why we see an incredible increase in drug prices across the entire industry. It is (part of the reason, at least) why there is massive upward price pressure on premiums, I think. The fact that the FDA only approved 18 drugs and medical devices in 2016 shows that it is an upward battle for the companies actually inventing and producing these drugs. That is ignoring the actual dollar cost that these companies experience over the decades they need to gain FDA approval, and most of them never actually do get their products approved. I think your discussion of the health insurance system was spot on and I wholly agree with everything you wrote, but I feel as if not enough attention is paid to the healthcare industry as a whole (especially by the mainstream media), when that industry and the health insurance industry are inherently tied together.